The NZETS commenced in July 2010 with fossil fuel and electricity sectors required to surrender NZU units to cover 50% of their C02 emissions or pay the Government $25. Certified Emissions Reductions or CER are fungible with NZU and acceptable in the NZETS.
Sectors at risk are either exempt or have received or will receive a ‘free’ allocation of NZU units. The fishing industry has received some 685,000 NZU units. Pre 1990 forest holders will receive units as compensation for loss of land use, or some 16m NZU pre 2012. Allocation is progressing at a slower pace than anticipated. Sectors will need to monetise these credits to offset losses.
Sales of NZU in July represented owners of post 1989 forests who were holding NZU units from forest growth in 2008 and 2009. A limited percentage of the eligible post 1989 forest has registered. Forest owners are wary of registering as the risks are only just becoming widely known.
July sellers received around $17 for their NZU units. Most of these sales were driven by forest managers who took large commissions. A bank moved in as a market maker purchasing NZU in lots as small as 100 units. This was marketed as being with ‘no commission’. In our view it was simply a buy/sell with a margin, however it did create a more transparent price point. Commentators suggest the price of NZU is capped at $25 less holding costs. Purchasing for surrender obligations in May 2011 incurs holding costs for emitters. Spot prices of NZU units increased to peak at $21.
Meantime the NZD Euro cross rate has improved to around 0.58. European confidence in CER from projects in developing countries has waivered. This has driven fluctuations in the price of CER units in the EUETS. In December 2010 combining these factors resulted in the price of a CER being less than the spot NZU. Emitters started purchasing CER instead of NZU units. The spot NZU slipped to around $19.
The NZU price is now capped by the price of a CER instead of the Government cap of $25. NZ compliance buyers are driven by price initially, being the cost of a compliance unit plus holding costs. CER delivery can be timed with next round of delivery in March 2011. This reduces holding costs. The CER market is significantly more liquid than the NZETS. This offers emitters the opportunity to hedge and provides a clearer exit opportunity. CER units are not constrained by the NZ Government limits on selling of NZUs. Coupled with transaction costs, the underlying credit in NZU often being forestry, and the reality that the CER is the denominating currency of the internationally traded market, given price parity with an NZU what option would a prudent buyer take?
What will happen long term? The NZETS review effective 2013 is expected to remove the price cap of $25 and require one unit surrendered for every tonne of C02 emitted. CER’s from industrial projects have been ruled unacceptable in the EUETS post may 2013 and may also be excluded from the NZETS. Otherwise there will be millions of CER’s post 2012 with the only market the NZETS. China’s floor of 9 Euro on a CER would drive the price of a CER and therefore compliance in the NZETS to 9 Euro or $15.51NZD.
Recently Barclays downgraded CER from 14.50 to 13.50 Euro. Point Carbon forecast 15.60 in 2011 rising to 18.40 Euro in 2012. At the current exchange rate Barclays suggest a CER of $23 NZD, and Point Carbon $26.90 NZD. Both of these projections significantly exceed the current NZU price and the latter exceeds the New Zealand Government cap of $25.
Is the phenomenon of the NZETS dominated by the CER price temporary? If the European projections prove correct the answer is yes.